RMB or QE? The truth behind the currency wars, and the real threat to the global economy

In 2010, Brazilian Finance Minister Guido Mantega sent ripples through the financial world by voicing something that had been on many people’s minds but remained unspoken: an “international currency war” was on the horizon.

In China, those fears go back even farther to 2007, when economist and former advisor to Fannie Mae and Freddie Mac Song Hongbing published The Currency Wars. Selling millions of copies and spawning three best-selling sequels, Song’s book went a step beyond Minister Mantega–the war had already begun, and even with an imminent banking collapse, a cabal of Western financiers would still come out on top.

In this podcast, the University of Toronto’s Rotman School of Management Professor Don Brean addresses the currency issue head on and gets at the heart of the controversy surrounding RMB appreciation and the Fed’s quantitative easing policies.

Just a War of Words?

For Brean, currencies and exchange rates are a big issue, but the term war might be taking it too far.

“To the extent that the war rhetoric in high places and newspapers prompts rash reaction, it’s not very helpful in dealing with the serious, and seriously complex, state of the global economic imbalance,” says Prof. Brean. “The spirit of global economic cooperation is now at risk of being lost or weakened. It now appears that it is each country for itself. That’s why there is some relevance for the war jargon.”

But the war is not just about words anymore.

In September 2011, the US Congress attempted to fight back against China’s RMB exchange rate, a policy some American politicians blame for create the US trade deficit. The bill would allow American companies to file WTO claims against Chinese manufactures for unfair pricing resulting from China’s control over its currency.

Senators voted heavily in favor of the bill, with long-time China-basher Chuck Schumer proclaiming, “No longer will Uncle Sam play Uncle Sap to China.” The bill is still awaiting a vote in the House.
Prof. Brean gives short shrift to this type of politicking. “Those who point the finger at the RMB exchange rate as the villain on the global economic stage are guilty of wishful thinking, dishonesty, or simply not understanding the issue well,” he says. “Global imbalances–in particular, the US massive fiscal deficit and the US mountain of debt–will not be corrected by RMB appreciation. That’s not enough.”

The QE Monster

So if China is not the culprit, who is? Here, Prof. Brean agrees with author Song Hongbin–although Brean’s a lot less conspiratorial.

“The greater threat to the world is the US dollar depreciation relative to all currencies,” the professor says. What he’s talking about is a policy that’s been easily accepted in the US, but highly controversial around the world–quantitative easing.

With QE, which is basically printing money, the Fed is devaluing the US dollar compared to other currencies, and that promises to knock the global economy even further out of balance.

That sounds like a scary prospect, but with advisers and economists like Prof. Brean around to help guide us, we just might make it.

Highlights of the interview

“The G20 meetings should not be expected to have clear definitively goals coming out of them. It’s a process [in which] much of the hard work is being done behind the scenes by bureaucrats and pre-conference meetings.”

“The issue of financial sector regulation is part of the process of establishing a stronger, more resilient international financial architecture.”

“The spirit of global economic cooperation is now at risk of being lost or weakened. It now appears that it is each country for itself. That’s why there is some relevance for the war jargon.”

“The world has become messier on the economic front.”

“Now the US is in a much more precarious state, and the US is much more nervous.”

“In the face of soft growth around the world, the incentives are great to do something–whatever works.”

“That process of competitive devaluations and restrictions on capital flows is very destructive in its own right, but is just a forerunner to more serious problems.”

“The two most serious battlefronts include China’s reticence on RMB flexibility and the potentially aggressive use of QE by the US.”

“The rigidity of the RMB reflects a degree of conservatism out of Chinese monetary authorities–which I respect, I respect their policy and their people, I respect their right to maintain and manage an exchange rate in light of domestic concerns in China. There’s a tremendous conflict in China between monetary authorities vs. those in the Ministry of Commerce that are doing everything they can to encourage industrial growth through exports. But I do believe the monetary authorities see the inevitable need of relaxation on the capital count, and flexibility in the currency, but it’s just a matter of when, not it. So that’s a timing issue and it shouldn’t be driven by the immediacy of concerns in the US.”

“RMB flexibility will be helpful when it comes, but it’s hard to say how helpful.”

“The RMB is overvalued relative to the US dollar, but it’s not necessarily significantly overvalued relative to other currencies, but it’s the fixity that’s bothering the US. It may not be bothering other nations in the world too much.”

“The Fed would buy assets that are outstanding, which would increase US dollar liquidity and would set the stage for dollar weakening against all other currencies.”

“The greater threat to the world…is the US dollar depreciation relative to all currencies.”

“I worry that the G20 might sooner or later regress into the G2–the US and China.”

“China has more on its agenda than simply export promotion via managing its currency.”

“US wage inflation is unlikely to be great in the near term. However, we know China has wage inflation. And whenever one country inflates more rapidly than another, then the country that’s inflating more rapidly experiences a real currency appreciation.”

“Those who point the finger at the RMB exchange rate as the villain on the global economic stage are guilty of wishful thinking, dishonesty, or simply not understanding the issue well.”

“The world’s economic problems and imbalances are deeply rooted in national policies, such as tax policies and entitlement policies. Inconsistency in national economic priorities and the wherewithal of those nations to achieve them too offer lead to intervention and protection.”

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Information, analysis, and interviews about the Chinese economy and doing business in China, from the people who know it best. Presented by the Cheung Kong Graduate School of Business, China's leading business school.